Mr. Volcker's Message

July 25, 1986

PAUL A. VOLCKER, the chairman of the Federal Reserve Board, has a double message for the people who make the world's economic policy. For the Americans, he offered a warning that they can't afford to resolve their gigantic trade deficit until they bring their federal budget deficit down. The trade deficit generates a flow of foreign lending that the United States needs to finance its dangerously unbalanced budget. Without that foreign lending, interest rates would soar. The flood of imports into this country is damaging American manufacturing industry. But neither the president nor Congress can do anything of significance to help the manufacturers as long as their domestic budget continues to require vast loans.

It's likely that the budget deficit will at least begin to decline next year. With that in mind, Mr. Volcker delivered another kind of warning to ''the rest of the industrial world'' -- essentially Japan and Germany. That enormous American budget deficit has pushed up demand, much of which is being supplied from the rest of the world -- that's the trade deficit. Japan and Europe have become highly dependent on their exports to the United States. If demand here drops along with the budget deficit, the only sensible response by the other industrial countries is to speed up their own internal economies to compensate. But so far they have adamantly resisted. If they persist, demand will fall worldwide. Mr. Volcker didn't say it -- he didn't have to -- but that is the definition of a world recession.

Why do Europe and Japan refuse to respond, in defiance of their own clear interests? Every government is reluctant to acknowledge, before its own voters, that in economic matters it is far from sovereign. Each, including the United States, is heavily dependent on its neighbors and trading partners -- a thought that grates on the common idea of independence. The whole delicate subject is usually left to professors and to politicians safely in retirement. Mr. Volcker is one of the few people in high office, in this country or any other, who makes it his business to keep reminding the world of the realities on which everybody's prosperity depends.

He was testifying before Congress this week, with a large and intent audience listening above all for hints about future interest rates. With the budget tightly locked in by law, monetary policy is about the only part of the economic steering mechanism that is still moveable. But large reductions in interest rates are inadvisable, Mr. Volcker said, because of concerns about inflation and the exchange rate. And, in his view, fiddling with minor changes in interest can't do much for economic growth in this country, much less abroad. To keep the expansion going will take much more forceful action, most of it in capitals other than this one.